<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___ TO ___
COMMISSION FILE NUMBER: 0-23289
HYBRID NETWORKS, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0252931
----------------------- ---------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6409 Guadalupe Mines Road, San Jose, California 95120
----------------------------------------------------------
(Address of principal executive offices)
(408) 323-6500
---------------------------------------------------------------
(Registrant's telephone number, including area code)
10161 Bubb Road, Cupertino, California 95014
- -------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if
changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes /X/ No (Such reports are filed concurrently herewith)
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common shares outstanding at May 28, 1999: 10,517,399
1
<PAGE>
HYBRID NETWORKS, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
PART I. CONDENSED FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Balance Sheets as of June 30, 1998
and December 31, 1997 (unaudited) 3
Condensed Statements of Operations for the Three
Months and Six Months Ended June 30, 1998
and 1997 (unaudited) 4
Condensed Statements of Cash Flows for the Six Months
Ended June 30, 1998 and 1997 (unaudited) 5
Notes to Unaudited Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS 11
ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK 25
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 26
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 28
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 29
SIGNATURES 30
</TABLE>
As used in this report on Form 10-Q, unless the context otherwise requires,
the terms "we," "us," or, "the Company" and "Hybrid" refer to Hybrid Networks,
Inc., a Delaware corporation.
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HYBRID NETWORKS, INC.
CONDENSED BALANCE SHEETS (unaudited)
(in thousands, except per share data)
<TABLE>
<CAPTION>
June 30, Dec. 31,
1998 1997
ASSETS ------- -------
(restated)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 10,048 $ 26,158
Restricted cash 506 --
Short-term investments 1,499 985
Accounts receivable, net of allowance for doubtful accounts
of $100 in 1998 and $0 in 1997 1,525 1,128
Inventories 8,803 6,270
Prepaid expenses and other current assets 465 362
-------- --------
Total current assets 22,846 34,903
Property and equipment, net 4,456 1,808
Intangibles and other assets 558 2,354
-------- --------
Total assets $ 27,860 $ 39,065
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Convertible debenture $ 5,500 $ 5,500
Current portion of capital lease obligations 494 410
Accounts payable 3,202 2,285
Accrued liabilities 2,268 2,913
-------- --------
Total current liabilities 11,464 11,108
Capital lease obligations, less current portion 586 618
Other long-term liabilities 13 36
-------- --------
Total liabilities 12,063 11,762
-------- --------
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock, $.001 par value:
Authorized: 5,000 shares;
Issued and outstanding: no shares in 1998 or 1997 -- --
Common stock, $.001 par value:
Authorized: 100,000 shares;
Issued and outstanding: 10,422 shares in 1998 and
10,345 shares in 1997 10 10
Additional paid-in capital 66,198 66,145
Unrealized gain on available-for-sale securities -- 92
Accumulated deficit (50,411) (38,944)
-------- --------
Total stockholders' equity 15,797 27,303
-------- --------
Total liabilities and stockholders' equity $ 27,860 $ 39,065
-------- --------
-------- --------
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
3
<PAGE>
HYBRID NETWORKS, INC.
CONDENSED STATEMENTS OF OPERATIONS (unaudited)
(in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ ------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
(restated) (restated)
<S> <C> <C> <C> <C>
Net sales $ 2,243 $ 515 $ 4,949 $ 895
Cost of sales 2,730 1,851 6,068 3,507
--------- --------- --------- ---------
Gross loss (487) (1,336) (1,119) (2,612)
--------- --------- --------- ---------
Operating expenses:
Research and development 3,335 1,652 5,833 3,447
Sales and marketing 936 989 1,890 2,331
General and administrative 1,896 521 2,824 1,116
--------- --------- --------- ---------
Total operating expenses 6,167 3,162 10,547 6,894
--------- --------- --------- ---------
Loss from operations (6,654) (4,498) (11,666) (9,506)
Interest income and other expenses, net 256 49 658 135
Interest expense (235) (147) (459) (159)
--------- --------- --------- ---------
NET LOSS (6,633) (4,596) (11,467) (9,530)
Other Comprehensive loss:
Reclassification for gain included in net loss -- -- (92) --
--------- --------- --------- ---------
Total Comprehensive Loss $ (6,633) $ (4,596) $ (11,559) $ (9,530)
--------- --------- --------- ---------
--------- --------- --------- ---------
Basic and diluted loss per share $ (0.64) $ (1.79) $ (1.10) $ (3.73)
--------- --------- --------- ---------
--------- --------- --------- ---------
Shares used in basic and diluted per share calculation 10,395 2,567 10,378 2,555
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
4
<PAGE>
HYBRID NETWORKS, INC.
CONDENSED STATEMENTS OF CASH FLOWS (unaudited)
(in thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
------------------------
1998 1997
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(11,467) $(9,530)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 1,085 299
Provision for doubtful accounts 100 15
Provision for excess and obsolete inventory -- 900
Write off technology license 1,283 --
Change in assets and liabilities:
Restricted cash (506) --
Accounts receivable (497) 901
Inventories (2,533) (2,814)
Prepaid expenses and other assets (190) (246)
Accounts payable 917 27
Accrued liabilities and other (668) 750
------- -------
Net cash used in operating activities (12,476) (9,698)
------- -------
Cash flows from investing activities:
Purchase of property and equipment (2,938) (322)
Disposal of property and equipment 17 --
Purchase of short-term investments (11,772) --
Proceeds from disposal of short-term investments 11,166 --
------- -------
Net cash used in investing activities (3,527) (322)
------- -------
Cash flows from financing activities:
Repayment of capital lease obligations (160) (65)
Net proceeds from issuance of convertible debenture -- 5,000
Net proceeds from issuance of preferred stock -- 2,000
Net proceeds from issuance of common stock 53 34
------- -------
Net cash provided by (used in) financing activities (107) 6,969
------- -------
Decrease in cash and cash equivalents (16,110) (3,051)
Cash and cash equivalents, beginning of period 26,158 6,886
------- -------
Cash and cash equivalents, end of period $ 10,048 $ 3,835
------- -------
------- -------
SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING ACTIVITIES:
Property and equipment acquired under capital leases $ 212 $ 507
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid 418 147
Income taxes paid 1 1
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
5
<PAGE>
HYBRID NETWORKS, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
BASIS OF PRESENTATION
The accompanying condensed financial statements of Hybrid Networks, Inc.
(the "Company" or "Hybrid") have been prepared in accordance with generally
accepted accounting principles for interim financial information and with the
instructions for Form 10-Q and Article 10 of Regulation S-X. The balance sheet
as of June 30, 1998, the statements of operations for the three months and six
months ended June 30, 1998 and 1997 and the statements of cash flows for the six
month periods ended June 30, 1998 and 1997 are unaudited but include all
adjustments (consisting of normal recurring adjustments) which the Company
considers necessary for a fair presentation of the financial position at such
dates and the operating results and cash flows for those periods. Although the
Company believes that the disclosures in these financial statements are adequate
to make the information presented not misleading, certain information normally
included in financial statements and related footnotes prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to the rules and regulations of the Securities and Exchange Commission.
The December 31, 1997 condensed balance sheet data were derived from audited
financial statements but do not include all disclosures required by generally
accepted accounting principles. The accompanying financial statements should be
read in conjunction with the financial statements as contained in the Company's
Annual Report on Form 10-K for the year ended December 31, 1998.
The accompanying financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. During the
first quarter of 1999 and the years ended December 31, 1998, 1997 and 1996,
the Company incurred net losses of $3,253,000, $24,625,000, $21,602,000 and
$8,515,000, respectively. Additionally, the Company had an accumulated
deficit of $66,822,000 as of March 31, 1999 and is highly dependent on its
ability to obtain sufficient additional financing in order to fund the
current and planned operating levels. Additionally, the Company is subject to
a number of lawsuits involving substantial dollar amounts, and is subject to
an official investigation by the Securities and Exchange Commission regarding
its financial reporting practices. These factors among others raise
substantial doubt about the ability of the Company to continue as a going
concern for a reasonable period of time.
The financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts
and classification of liabilities that might be necessary should the Company
be unable to continue as a going concern. The Company's continuation as a
going concern is dependent upon its ability to obtain additional financing to
continue its product development and marketing plans and to fund other
general operating expenses, achievement of a financially satisfactory
resolution to outstanding litigation and the SEC investigation, and
ultimately is dependent upon its ability obtain sufficient customer demand to
attain profitable operations. No assurance can be given that the Company will
be successful in these efforts.
Results for any interim period are not necessarily indicative of results
for any other interim period or for the entire year.
RESTATEMENT OF FINANCIAL STATEMENTS
Subsequent to the filing of its Annual Report on Form 10-K for the year
ended December 31, 1997 with the Securities and Exchange Commission, the Company
became aware of errors and irregularities that ultimately affected the timing
and dollar amount of reported product sales from product shipments in 1997 and
the first quarter of 1998.
The Company undertook and completed extensive procedures related to product
sales recorded in 1997 and the first quarter of 1998. As a result of these
findings and other relevant information now known or disclosed, the Company has
determined that a significant number and dollar amount of product shipments were
improperly reported as sales in the aforementioned periods.
The Company has determined that revenue is earned and should be recorded only
after any related obligations have been satisfied (i.e. when there are no longer
any significant remaining uncertainties related to the earnings process). This
revenue recognition policy has been followed for all transactions with customers
reflected in these financial statements.
Additionally, during 1998 the Company became aware that warrants to
purchase common stock issued and outstanding in 1997 had not been properly
valued, resulting in an understatement of both operating expenses and interest
expense. These warrants have now been properly valued and reflected in the
financial statements.
6
<PAGE>
As a result of the above, the statements of operations for the six months
ended June 30, 1997 have been restated as follows:
<TABLE>
<CAPTION>
Six Months Ended
June 30, 1997
-------------------------
Previously
Restated Reported
-------- ---------
<S> <C> <C>
Net sales $ 895 $ 4,905
Cost of sales 3,507 4,689
------- -------
Gross profit (loss) (2,612) 216
------- -------
Operating expenses:
Research and development 3,447 3,379
Sales and marketing 2,331 2,264
General and administrative 1,116 1,802
------- -------
Total operating expenses 6,894 7,445
------- -------
Loss from operations (9,506) (7,229)
Interest income and other
expenses, net. 135 135
Interest expense (159) (159)
------- -------
Net loss $(9,530) $(7,253)
------- -------
------- -------
Basic and diluted loss per share $ (3.73) $ (2.84)
------- -------
------- -------
Shares used in basic and diluted
per share calculation 2,555 2,555
------- -------
------- -------
</TABLE>
COMPUTATION OF BASIC AND DILUTED LOSS PER SHARE
Basic earnings per share excludes dilution and is computed by dividing
income available to common stockholders by the weighted average number of shares
of common stock outstanding for the period. Diluted earnings per share reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock or resulted in
the issuance of common stock that then shared in the earnings of the entity. All
such securities or other contracts were anti-dilutive for all periods presented
and, therefore, excluded from the computation of earnings per share. In February
1998, the Securities and Exchange Commission issued Staff Accounting Bulletin
(SAB) No. 98, which addresses the computation of earnings per share in an
initial public offering. The Company has determined that no incremental shares
should be included in the computation of earnings per share in accordance with
the SAB and basic and diluted loss per share has been restated accordingly.
7
<PAGE>
INVENTORIES
Inventories comprise the following:
<TABLE>
<CAPTION>
June 30, Dec. 31,
1998 1997
------ ------
(restated)
<S> <C> <C>
Raw materials $2,834 $2,175
Work in progress 475 229
Finished goods 5,494 3,866
------ ------
$8,803 $6,270
------ ------
------ ------
</TABLE>
CONTINGENCIES
CLASS ACTION LITIGATION
In June 1998, five class action lawsuits were filed in San Mateo County
Superior Court, California against the Company, its five directors (one of whom
is an officer), two former officers and one former director. The lawsuits were
brought on behalf of purchasers of the Company's Common Stock during the class
period commencing November 12, 1997 (the date of the Company's initial public
offering) and ending June 1, 1998. In July 1998, a sixth class action lawsuit
was filed in the same court against the same defendants, although the class
period was extended to June 18, 1998. All six lawsuits also named as defendants
the underwriters in the Company's initial public offering, but the underwriters
have since been dismissed from the cases.
The complaints in these lawsuits claim that the Company and the other
defendants violated the anti-fraud provisions of the California securities laws,
alleging that the financial statements used in connection with the Company's
initial public offering and the financial statements issued subsequently during
the class period, as well as related statements made on behalf of the Company
during the initial public offering and subsequently regarding the Company's past
and prospective financial condition and results of operations, were false and
misleading. The complaints also allege that the Company and the other defendants
made these misrepresentations in order to inflate the price of the Company's
Common Stock stock for the initial public offering and during the class period.
The Company and the other defendants denied the charges of wrongdoing.
In July and August 1998, two class action lawsuits were filed in the
U.S. District Court for the Northern District of California. Both of these
federal class action lawsuits were brought against the same defendants as the
six state court class actions referred to above, except that the second
federal class action lawsuit also named as a defendant PricewaterhouseCoopers
LLP (PwC), the Company's former independent accountants. (The underwriters in
the Company's initial public offering were named as defendants in the first
federal class action lawsuit but were subsequently dismissed.) The class
period for the first federal class action lawsuit is from November 12, 1997
to June 1, 1998, and the class period in the second class action lawsuit
extends to June 17, 1998. The complaints in both federal class action
lawsuits claim that the Company and the other defendants violated the
anti-fraud provisions of the federal securities laws, on the basis of
allegations that are similar to those made by the plaintiffs in the state
class action lawsuits. The Company and the other defendants denied these
charges of wrongdoing.
In March 1999, the Company and the other parties (other than PwC) to the
state class action lawsuits and the federal class action lawsuits reached an
agreement in principle to settle the lawsuits. The agreement is subject to the
parties' entering into a binding stipulation of settlement
8
<PAGE>
and approval by the U.S. District Court for the Northern District of
California. Under the agreement in principle, (i) the Company's insurers
would pay $8.8 million on the Company's behalf (and on behalf of the other
officer and director defendants), (ii) the Company would issue 3.0 million
shares of Common Stock to the plaintiffs (the number of shares would be
increased proportionately to the extent that there are more than 10.5 million
shares of Common Stock outstanding on the date of distribution so that, as of
such date, the plaintiffs would hold approximately 22.6% of all of the shares
of the Company's Common Stock that are then outstanding), (iii) if the
Company is acquired within nine months after March 9, 1999, the date of the
agreement in principle, then, in addition to the consideration referred to in
(i) and (ii), the Company would pay to the plaintiffs an amount equal to 10%
of the consideration received by the Company's stockholders in the
acquisition. As a result of the agreement in principle and a related
agreement between the Company and its insurers, the Company has paid, and
will not be reimbursed by its insurers for, $1.2 million in attorneys fees
and other litigation expenses that would otherwise be covered by our
insurance, and the Company will not have insurance coverage for the attorneys
fees and expenses relating to the settlement that it incurs in the future. As
of December 31, 1998 the Company has accrued $1,547,000 for the value of the
3,000,000 shares to be issued in the settlement.
SEC INVESTIGATION
In October 1998, the Securities and Exchange Commission began a formal
investigation of the Company and unidentified individuals with respect to the
Company's financial statements and public disclosures. The Company has been
producing documents in response to the Securities and Exchange Commission's
subpoena and is cooperating with the investigation. A number of current and
former officers and employees and outside directors have testified or may
testify before the Securities and Exchange Commission's staff. The Company does
not believe, based on current information, that this investigation will have a
material adverse impact on the Company's financial statements.
PATENT LITIGATION
In January 1998, the Company brought a lawsuit in the U.S. District Court
for the Eastern District of Virginia against Com21, Inc. and Celestica, Inc. in
which the Company alleged that the defendants infringed the Company's patents.
In response to the Company's lawsuit, Com21 initiated a declaratory judgment
action six days later in the U.S. District Court for the Northern District of
California to obtain a declaration that the Company's patents are invalid and
unenforceable and that in any event Com21 did not infringe them. In February
1998, the action in the Eastern District of Virginia was transferred to the
Northern District of California, and the two actions were consolidated.
Pre-trial discovery continued in the consolidated action until September 1998
when the parties agreed to stay the proceedings while they attempted to reach a
settlement.
In January 1999, the Company entered into a settlement agreement with
Com21, Inc. and Celestica, Inc. whereby the patent lawsuits were settled.
Pursuant to the agreements, the Company granted Com21 and Celestica a
nonexclusive license on the Company's patents under which they may be
required to pay royalties in the event that they sell certain products in the
future, subject to certain contingencies, and the Company granted to Com21 a
right of first refusal to purchase the patents in the event that the Company
should propose in the future to sell its patents (whether separately or
together with the Company's other assets to any third party). The Company has
agreed to pay its legal counsel in this action, as a partial contingency fee
(in return for such counsel's acceptance of reduced current legal fees), an
amount equal to 50% of any royalties that the Company receives from its
license with the defendants in the litigation (but not in excess of
$3,000,000). To date, the Company has received virtually no royalties from
the license.
LAWSUIT BY PACIFIC MONOLITHICS
In March 1999, Pacific Monolithics, Inc. (which had filed a voluntary
petition under Chapter 11 of the U.S. Bankruptcy Code and is suing as
debtor-in-possession) filed a lawsuit in Santa Clara County Superior Court,
California against the Company, its five directors (one of whom is an officer),
a former director (who was subsequently dismissed), a former officer and PwC.
The lawsuit concerns
9
<PAGE>
an agreement which the Company entered into in March 1998 to acquire Pacific
Monolithics through a merger, which acquisition was never consummated. The
complaint alleges that the Company induced Pacific Monolithics to enter into
the agreement by providing it with financial statements, and by making other
representations concerning the Company's financial condition and results of
operations, which were false and misleading, and further alleges that the
Company wrongfully failed to consummate the acquisition. The complaint claims
the defendants committed breach of contract and breach of implied covenant of
good faith and fair dealing, as well as fraud and negligent
misrepresentation. The complaint seeks compensatory and punitive damages
according to proof, plus attorneys' fees and costs. The plaintiff has
attempted to initiate discovery, which defendants have opposed on the basis
that the plaintiff and the Company had agreed that any disputes would be
submitted to arbitration. The defendants have filed a motion to compel
arbitration and to stay the court action. The Company does not believe, based
on current information (which is only preliminary, since discovery has not
commenced in the litigation), that the outcome of this litigation will have a
material adverse impact on the Company's financial statements.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE DISCUSSION IN THIS ITEM SHOULD BE READ IN CONJUNCTION WITH THE
CONDENSED FINANCIAL STATEMENTS AND THE NOTES THERETO INCLUDED IN ITEM 1 OF THIS
REPORT ON FORM 10-Q. THE DISCUSSION IN THIS ITEM CONTAINS FORWARD-LOOKING
STATEMENTS RELATING TO FUTURE EVENTS OR FINANCIAL RESULTS, SUCH AS STATEMENTS
INDICATING THAT "WE BELIEVE," "WE EXPECT," "WE ANTICIPATE" OR "WE INTEND" THAT
CERTAIN EVENTS MAY OCCUR OR CERTAIN TRENDS MAY CONTINUE. OTHER FORWARD-LOOKING
STATEMENTS INCLUDE STATEMENTS ABOUT THE FUTURE DEVELOPMENT OF PRODUCTS OR
TECHNOLOGIES, MATTERS RELATING TO OUR PROPRIETARY RIGHTS, YEAR 2000 COMPLIANCE,
FACILITIES NEEDS, OUR LIQUIDITY AND CAPITAL NEEDS AND OTHER STATEMENTS ABOUT
FUTURE MATTERS. ALL THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND
UNCERTAINTIES. YOU SHOULD NOT RELY TOO HEAVILY ON THESE STATEMENTS; ALTHOUGH
THEY REFLECT THE GOOD FAITH JUDGMENT OF OUR MANAGEMENT, THEY INVOLVE FUTURE
EVENTS THAT MIGHT NOT OCCUR. WE CAN ONLY BASE SUCH STATEMENTS ON FACTS AND
FACTORS THAT WE CURRENTLY KNOW. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THOSE IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS,
INCLUDING THOSE SET FORTH UNDER "RISK FACTORS" AND ELSEWHERE IN THIS REPORT ON
FORM 10-Q.
OVERVIEW
GENERAL
We are a broadband access equipment company that designs, develops,
manufactures and markets wireless and cable systems that provide high speed
access to the Internet and corporate intranets for both businesses and
consumers. Our products remove the bottleneck over the local connection to the
end-user which causes slow response time for those accessing bandwidth-intensive
information. Our Series 2000 product line consists of secure headend routers,
wireless and cable modems and management software for use with either wireless
transmission or cable TV facilities.
We sell our products primarily in the United States. Our customers include
broadband wireless system operators, cable system operators, ISPs, resellers and
certain distributors and communications equipment resellers. Historically, a
small number of customers has accounted for a substantial portion of our net
sales, and we expect the trend to continue. As a result, we have experienced,
and expect to continue to experience, significant fluctuations in its results of
operations on a quarterly and an annual basis. The sales cycle for our products
has been lengthy, generally lasting three to nine months, and is subject to a
number of significant risks, including customers' budgetary constraints and
internal acceptance reviews. Because our sales cycle may be long and uncertain,
and because we depend on relatively few customers who place relatively large
orders, any delay or loss of an order that is expected to be received in a
quarter can have a major effect on our sales and operating results for that
quarter. The same is true of any failure of a customer to pay for products on a
timely basis.
The market for high speed network connectivity products and services is
intensely competitive and is characterized by rapid technological change, new
product development and product obsolescence, and evolving industry standards.
Our ability to develop and offer competitive products on a timely basis that
satisfy industry demands, such as for two-way QPSK, or industry standards
11
<PAGE>
such as DOCSIS, could have a material effect on our business. In addition,
the market for our products has historically experienced significant price
erosion over the life of a product, and we have experienced and expect to
continue to experience pressure on our unit average selling prices. While we
have initiated cost reduction programs to offset pricing pressures on our
products, there can be no assurance that we will keep pace with competitive
price pressures or improve our gross margins. If we are unable to continue to
reduce costs quickly enough, our profitability will be adversely affected.
Our profitability is also affected by the sales mix of headends and modems.
Our single-user modems generally have lower margins than our multi-user
modems, both of which have lower margins than our headend routers. Due to
current customer demand, we anticipate that the sales mix of modems will be
weighted toward lower-margin single-user modems in the foreseeable future. As
a result, our gross margins, and our business, could be adversely affected.
Due to our diminishing capital resources (See "--Liquidity and Capital
Resources"), during the first quarter of 1999 we reduced our expenditures for
research and development and sales and marketing. In February 1999, we
implemented a reduction in force. As of April 31, 1999, the number of our
full-time employees had been reduced to 32, from 87 full-time employees at
December 31, 1998
RESTATEMENT OF OUR FINANCIAL STATEMENTS
In May and June 1998, we and PwC, our independent auditors, engaged in a
review of our financial statements for 1997 and the first quarter of 1998. On
June 18, 1998, we announced that PwC had notified us that its audit reports on
our 1997 financial statements should no longer be relied upon and that we and
they were continuing to review those financial statements. On July 9, 1998, PwC
resigned as our independent auditors, stating that it believed our 1997
financial statements should be restated but that, although there had been no
disagreements between PwC and us on any matter of our accounting principles, or
practices, financial statement disclosure or auditing procedure, PwC would not
continue as our independent auditors to address the restatement.
In August 1998, we retained Arthur Andersen LLP ("AA") as our independent
auditors. After extensive work in examining our 1997 financial statements, AA
resigned as our independent auditors on November 24, 1998. AA informed us that,
in its view, material weaknesses existed in our internal controls of a nature
that prevented AA from being able to form an opinion of our conclusions as to
the appropriate timing and amount of revenue recognition for the purposes of our
1997 financial statements. AA also stated that, during the course of its work,
it had reached the conclusion that it needed to expand significantly the scope
of its audit, which it did with our approval and cooperation, and that, while AA
did not complete its audit, it concluded that our 1997 financial statements were
materially misstated. AA confirmed that there had been no disagreements between
AA and us on any matter of our accounting principles and practices, financial
statement disclosure or auditing procedure.
In December 1998, we engaged Hein + Associates LLP ("Hein") as our
independent auditors. During the review of our financial statements in
conjunction with Hein (and earlier with Pwc and AA), we became aware of errors
and irregularities that caused our financial statements for 1997 and the first
quarter of 1998 to be misstated, particularly with respect to the timing and
amount of our sales in 1997 and the first quarter of 1998. We also concluded
that the financial effects of warrants issued by us in 1997 had not been
properly reflected in our financial statements. Our financial statements for
1997 and the first quarter of 1998 have been restated to correct these errors.
As a result of the restatement net sales for the first quarter of 1998 was
increased from $915,000 to $2,706,000, gross loss was $632,000 rather than a
gross loss of $266,000, and net loss was reduced to $4,834,000 from $5,224,000.
In June 1999, Hein completed its audit of our 1997 and 1998 financial
statements. Those financial statements, and Hein's audit report on them are
included in the report on Form 10-K for 1998.
12
<PAGE>
Our inability to issue audited financial statements and quarterly reports
during the last 12 months has had serious consequences for our business. As a
result, the Nasdaq National Market suspended trading in our Common Stock from
June 18, 1998 to December 1, 1998, at which time our Common Stock was delisted
from the Nasdaq National Market. Primarily due to our announcements regarding
the need to restate our financial statements, a number of class action
litigations were brought in June, July and August 1998, and the Securities and
Exchange Commission initiated a formal investigation in October 1998. We believe
these actions hurt our business during the latter part of 1998, made it more
difficult for us to attract and retain employees, disrupted our management,
sales and marketing, engineering and research and development staffs,
contributed to our inability to complete the restatement of our financial
statements during 1998 and 1999 and adversely affected the sales of our products
and services.
RESULTS OF OPERATIONS
The following table sets forth the percentage of net sales represented by
the items in our statements of operations for the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------------
1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
Net Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 121.7% 359.4% 122.6% 391.8%
------ ------ ------ ------
Gross margin -21.7% -259.4% -22.6% -291.8%
------ ------ ------ ------
Operating expenses
Research and development 148.7% 320.8% 117.9% 385.1%
Sales and marketing 41.7% 192.0% 38.2% 260.4%
General and administrative 84.5% 101.2% 57.0% 124.7%
------ ------ ------ ------
Total operating expenses 274.9% 614.0% 213.1% 770.2%
------ ------ ------ ------
Loss from operations -296.6% -873.4% -235.7% 1,062.0%
Interest income and other expense, net 11.4% 9.5% 13.3% 15.1%
Interest expense -10.5% -28.5% -9.3% -17.8%
------ ------ ------ ------
Net loss -295.7% -892.4% -231.7% -1,064.7%
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
NET SALES. Our net sales increased by 336% to $2,243,000 for the quarter
ended June 30, 1998 from $515,000 for the quarter ended June 30, 1997, and
increased by 453% to $4,949,000 for the six months ended June 30, 1998 from
$895,000 for the six months ended June 30, 1997. The increases in net sales
are primarily due to increased unit shipments of the Series 2000 product line
offset in part by price declines on certain products as a result of
competitive pressures and volume purchase commitments. For the three months
ended June 30, 1998, broadband wireless systems operators, cable system
operators and ISPs accounted for 51%, 42% and 7% of net sales, respectively.
During the same period in 1997, broadband wireless system operators accounted
for 62% of net sales, cable system operators accounted for 28% of net sales
and ISPs accounted for 10% of net sales. We had three customers that
accounted for 21%, 14% and 10% of net sales during the three months ended
June 30, 1998; and four customers that accounted for 17%, 16%, 15% and 13% of
net sales for the comparable period in 1997.
13
<PAGE>
GROSS MARGIN. Gross margin was a negative 21.7% and a negative 259.4% of
net sales for the quarters ended June 30, 1998 and 1997, respectively. For the
first half of 1998 and 1997, gross margin was a negative 22.6% and a negative
291.8% of net sales, respectively. The increase in gross margin was due to a
decrease in the provision for excess and obsolete inventory in 1998, as well as
increased unit shipments resulting in better utilization of fixed costs.
RESEARCH AND DEVELOPMENT. Research and development expenses include
ongoing headend, software and cable modem development expenses, as well as
design expenditures associated with product cost reduction programs and
improving manufacturability of its existing products. Research and
development expenses increased 101.9% to $3,335,000 for the quarter ended
June 30, 1998 from $1,652,000 for the quarter ended June 30, 1997, and
increased 69.2% to $5,833,000 for the six months ended June 30, 1998 from
$3,447,000 for the six months ended June 30, 1997. Research and development
expenses as a percentage of net sales were 145.0% and 320.8% for the second
quarters of 1998 and 1997, respectively, and were 116.2% and 385.1% for the
first half of 1998 and 1997, respectively Research and development expenses
grew in absolute dollars as a result of increased staffing and associated
engineering costs related to new and existing product development.
SALES AND MARKETING. Sales and marketing expenses consist primarily of
salaries and related payroll costs of sales and marketing personnel,
commissions, advertising, promotions and travel. Sales and marketing expenses
decreased 5.4% to $936,000 for the quarters ended June 30, 1998 from $989,000
for the quarter ended June 30, 1997, and decreased 18.9% to $1,890,000 for
the six months ended June 30, 1998 from $2,331,000 for the six months ended
June 30, 1997. Sales and marketing expenses as a percentage of net sales were
41.7% and 192.0% for the second quarters of 1998 and 1997, respectively, and
were 38.2% and 260.4% for the first half of 1998 and 1997, respectively. The
decrease in sales and marketing expenses in absolute dollars was principally
due to lower trade show, promotion and outside service costs. The decrease in
sales and marketing expenses was partially offset by increased headcount and
related payroll costs and, increased commissions as a result of higher net
sales.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of executive personnel salaries, provision for doubtful accounts,
travel expenses, legal fees and costs of outside services. General and
administrative expenses increased 263.9% to $1,896,000 for the quarter ended
June 30, 1997 from $521,000 for the quarter ended June 30, 1998, and
increased 153.0% to $2,824,000 for the six months ended June 30, 1997 from
$1,116,000 for the six months ended June 30, 1998. General and administrative
expenses as a percentage of net sales were 84.5% and 101.2% for the second
quarters of 1998 and 1997, respectively, and were 57.0% and 124.7% for the
first half of 1998 and 1997, respectively. The increase in absolute dollars
was due to increased headcount and related payroll costs, increased legal
costs to support our Company's patent program and higher outside service
costs.
INTEREST INCOME (EXPENSE) AND OTHER EXPENSE, NET. We earned net interest
income of $21,000 and $199,000 during the three and six months ended June 30,
1998, respectively. We incurred net interest expense of $98,000 and $24,000
during the three and six months ended June 30, 1997, respectively. Net interest
income earned during the three and six months ended June 30, 1998 was the result
of higher cash balances as a result of the issuance of Common Stock in our
initial public offering in November 1997, offset in part by the interest expense
incurred on outstanding capital lease obligations and the $5.5 million secured
convertible debenture due 2002.
LIQUIDITY AND CAPITAL RESOURCES
We have historically financed our operations primarily through a
combination of debt, equity and equipment lease financing. As of June 30, 1998,
we had working capital of $10,382,000, including $11,547,000 in cash, cash
equivalents and short-term investments, as compared to working capital of
$23,795,000 and $27,143,000 in cash, cash equivalents and short-term investments
as of December 31, 1997. This $15,596,000 decrease in cash, cash equivalents and
short-term investments during the six months ended June 30, 1998 resulted from
the use of cash in operating activities, investing activities and financing
activities discussed below.
14
<PAGE>
Cash used in operating activities during the six months ended June 30,
1998 was $12,476,000, resulting primarily from the net loss of $11,467,000.
Noncash charges for depreciation and amortization, provision for doubtful
accounts and obsolete inventory and write-off of technology totaling
$2,468,000 were more than offset by a net increase in current assets
affecting operating activities of $3,477,000. Cash used in operating
activities during the six months ended June 30, 1997 was $9,698,000 resulting
primarily from the net loss of $9,530,000.
Cash used in investing activities during the six months ended June 30, 1998
was $3,527,000, resulting primarily from purchases of property and equipment of
$2,938,000. During the six months ended June 30, 1998, capital expenditures for
property and equipment were primarily for leasehold improvements in connection
with new subleased headquarters. During this period, we purchased short-term
investments of $11,772,000 and received $11,166,000 in proceeds from the
liquidation of short-term investments. We have funded and expect to continue to
fund a substantial portion of our property and equipment expenditures from a
variety of sources including direct vendor leasing programs and third party
commercial leasing arrangements.
Cash used in financing activities during the six months ended June 30, 1998
was $107,000, attributable primarily to payment of capital lease obligations
partially offset by net proceeds from issuance of common stock. Cash provided by
financing activities for the six months ended June 30, 1997 was primarily the
result of proceeds from issuance of convertible debt and the issuance of
preferred stock.
At March 31, 1999, our only source of liquidity consisted of cash and cash
equivalents of $2,837,000. We had no available line of credit or other source of
borrowings or financing. As indicated above, we were (and are) not in compliance
with certain of the terms of the $5.5 Million Debenture and, as a result, the
holder of the debenture has the right to declare a default under the debenture
at any time. Our obligations under the $5.5 Million Debenture are collateralized
by a security interest in substantially all our assets. We will need to raise
additional capital promptly in order to offset our expected future operating
losses.
To fund our operations during 1999 and continue as a going concern, we are
seeking to raise additional capital through debt or equity financing, but there
is no assurance that we will be able to do so. If we do obtain additional
financing, it may be on terms that would be unfavorable to us and may hurt our
ability to raise further capital in the future.
SEASONALITY AND INFLATION
The Company does not believe that its business is seasonal or that it is
impacted by inflation.
RISK FACTORS
AN INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. YOU
SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW AND THE OTHER INFORMATION IN
THIS REPORT ON FORM 10-Q BEFORE INVESTING IN OUR COMMON STOCK. THE RISKS
DESCRIBED BELOW ARE NOT THE ONLY ONES WE FACE. ADDITIONAL RISKS THAT WE ARE
AWARE OF OR THAT WE CURRENTLY BELIEVE ARE IMMATERIAL MAY BECOME IMPORTANT
FACTORS THAT AFFECT OUR BUSINESS. IF ANY OF THE FOLLOWING RISKS OCCUR, OR IF
OTHERS OCCUR, OUR BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION COULD BE
SERIOUSLY HARMED.
WE WILL NEED ADDITIONAL CAPITAL SOON TO CONTINUE IN BUSINESS.
Although we raised over $35 million in net proceeds from our initial public
offering in November 1997, our capital resources are now largely depleted. We
are not in compliance with certain terms of the $5.5 Million Debenture, and, as
a result, the holder of the debenture may declare a default under the debenture
at any time. We currently do not have the capital resources to make such
payment. Should we fail to make payment on demand, the debenture holder may
elect, subject to certain restrictions and limitations, to exercise its security
interest in all our assets, which may involve the seizure and sale of our
assets. We will nonetheless need to raise additional capital in order to
continue in operation. Our ability to raise additional capital has been limited
by a number of factors, including (i) our noncompliance with certain terms of
the $5.5 Million Debenture, (ii) our not having audited financial statements for
1997 or 1998 or a quarterly report for the first quarter of 1999, (iii) our
Common Stock being delisted from the Nasdaq National Market and not traded on
15
<PAGE>
any other public market (except for a small number of sales on the Pink Sheets
which have occurred without our consent), (iv) the state and federal class
action litigation and the Securities and Exchange Commission investigation that
are pending against us (although we have agreed in principle to settle the class
action litigation, that agreement is not yet final), (v) uncertainty which the
foregoing has caused regarding our financial condition and results of
operations, (vi) the adverse effect which the foregoing has had on sales to our
customers, (vii) the disruption in our management and our employees caused by
the foregoing, including the substantial reduction in force we implemented in
February 1999, (viii) our history of heavy losses and (ix) the other risk
factors referred to herein. We can give no assurance that, within a short period
of time, we will be able to raise the additional capital we need or that any
financing we may be able to obtain will not be on terms that are detrimental to
our business and our ability to raise additional capital.
IT IS NOT CLEAR THAT WE WILL BE ABLE TO RECOVER FROM THE ADVERSE EFFECTS OF
HAVING TO RESTATE OUR FINANCIAL STATEMENTS.
The adverse effects of having to restate our financial statements have been
severe, and there can be no assurance that we will not suffer additional adverse
consequences in the future. The restatement and related issues have resulted in
the resignation of two successive audit firms that were hired by us, in our
continuing for 12 months as a public company without having audited financial
statements, in the multiple class action lawsuits, the Securities and Exchange
Commission and the Pacific Monolithics litigation referred to in Item 3 "Legal
Proceedings" above and in the other adverse consequences referred to in the
preceding paragraph. We do not know whether additional litigation will arise in
the future, or whether other adverse developments will result, from the
difficulties we have encountered in connection with our financial statements.
OUR LIMITED OPERATING HISTORY AND HEAVY LOSSES MAKE OUR BUSINESS DIFFICULT
TO EVALUATE.
We were organized in 1990 and have had operating losses each year since
then. Our accumulated deficit was $63,569,000 as of December 31, 1998 and
$66,822,000 as of March 31, 1999. The revenue and profit potential of our
business is unproven. The market for our products has only recently begun to
develop, is rapidly changing, has an increasing number of competing technologies
and competitors, and many of the competitors are significantly larger than we
are. We have had negative gross margins in the past and the price pressures on
sales of our products continues. We expect to incur losses for the foreseeable
future.
WE FACE LITIGATION RISKS.
As indicated in Item 1 "Legal Proceedings," there are a number of lawsuits
pending against us. The principal lawsuits are the class action lawsuits
referred to therein. Although we have reached an agreement in principle to
settle these lawsuits, the agreement is subject to the parties' entering into a
binding stipulation of settlement, which has not yet occurred, and upon the
subsequent approval of the settlement by the court in a hearing at which any
persons opposing the settlement will have an opportunity to be heard. If the
settlement is not consummated, we could be subjected to lengthy, expensive and
potentially damaging class action litigation.
It is difficult for us to evaluate what the outcome of the Securities and
Exchange Commission investigation (referred to in Item 1 "Legal Proceedings")
will be. Responding to the investigation has been, and probably will be,
expensive and time-consuming for us. We do not know whether the results of the
investigation will be damaging for us.
The Pacific Monolithics litigation referred to in Item 1 "Legal
Proceedings" is in its early stages and is difficult for us to evaluate at this
point.
It is possible that we may be exposed to further litigation in the future,
particularly in light of the restatement of our financial statements, and the
adverse developments that have occurred partly as a result of the restatement
(see the two risk factors immediately above). In addition, litigation may be
necessary in the future to enforce our intellectual property rights or to
determine the validity and
16
<PAGE>
scope of our patents or of the proprietary rights of others. Such litigation
might result in substantial costs and diversion of resources and management
attention. Furthermore, our business activities may infringe upon the
proprietary rights of others, and in the past third parties have claimed, and
may in the future claim, infringement by our software or products. Any such
claims, with or without merit, could result in significant litigation costs
and diversion of management attention, and could require us to enter into
royalty and license agreements that may be disadvantageous to us or suffer
other harm to our business. If litigation is successful against us, it could
result in invalidation of our proprietary rights and liability for damages,
which could have a harmful effect on our business. We initiated one patent
infringement litigation to enforce our patent rights, and it resulted in a
settlement in which we granted licenses to the defendants containing terms
that are in some respects favorable to them, including a right of first
refusal to purchase our patents that we granted to one defendant (Com21,
Inc.) in the event that we propose in the future to sell our patents (whether
we separately or together with our other assets) to any third party. (See
Item 1 "Legal Proceedings.") Nonetheless, we may find it necessary to
institute further infringement litigation in the future, or whether third
parties will bring litigation against us challenging our patents.
RECENT REDUCTIONS IN OUR EXPENDITURES AND IN THE NUMBER OF OUR EMPLOYEES
COULD HURT OUR BUSINESS.
Commencing in the latter part of 1998 and continuing through the first
quarter of 1999, we began to reduce our expenditures on research and development
and on other aspects of our business. We also began to reduce the number of our
employees. During the first quarter of 1999 we implemented a reduction in force
that reduced the number of full-time employees to 32, as compared to 87
full-time employees at December 31, 1998. We used consultants heavily to
supplement our workforce and as of April 30, 1999 we had 14 consultants in
various areas. While we believe these reductions were necessary to conserve our
remaining capital resources, they have limited and delayed the enhancement of
our products and our development of new products, and our sales and marketing
efforts have been adversely affected. These limitations on our activities,
(together with the other factors referred to above and elsewhere herein), have
hurt us competitively and may continue to harm our business in the future. We do
not know whether we will be successful in obtaining sufficient capital resources
to expand our business in the future.
MARKET PRESSURE TO REDUCE PRICES MAY HURT OUR BUSINESS.
The market has historically demanded increasingly lower prices for our
products, and we expect downward pressure on the prices of our products to
continue. The list prices for our Series 2000 client modems currently range from
approximately $320 to $480, depending upon features and volume. Customers
wishing to purchase client modems generally must also purchase an Ethernet
adapter for their computer. These prices make our products relatively expensive
for the consumer electronics and the small office or home office markets. Market
acceptance of our products, and our future success, will depend in significant
part on reductions in the unit cost of our client modems. In a number of
instances, the prices of our competitors' products are lower than ours. Our
ability to reduce our prices has been limited by a number of factors, including
our reliance on a single manufacturer of our modems and on single-sources for
certain of the components of our products.
One of the principal objectives of our research and development efforts has
been to reduce the cost of our products through design and engineering changes,
although, as indicated above, we have recently had to reduce the scope of our
research and development efforts due to lack of capital resources. We have no
assurance that we will be able to redesign our products to achieve substantial
cost reductions or that we will otherwise be able to reduce our manufacturing
and other costs, or that any reductions in cost will be sufficient to improve
our gross margins, which have historically been negative.
We expect that the market price pressure to reduce the prices on our
products will continue to exert downward pressure on our gross margins. Our
gross margins are also affected by the sales mix of our headends and modems. Our
single-user modems generally have lower margins than our multi-user modems, both
of which have lower margins than our headends. We anticipate that, due
17
<PAGE>
to customer demand, the sales mix of our products will continue to be
weighted toward lower-margin single-user modems.
WE RELY ON A SINGLE MANUFACTURER FOR OUR MODEMS AND ON SINGLE-SOURCE
COMPONENTS.
Our Series 2000 client modems are manufactured by Sharp Corporation through
an agreement we have had since early 1997 with Sharp and its distributor, Itochu
Corporation. We have not developed an alternative manufacturing source. Our
inability to develop alternative manufacturing sources has adversely affected
our ability to reduce the manufacturing costs of our modems despite competitive
pressures that have caused us to reduce our selling prices. We expect downward
pressure on the prices of our products to continue. In order for us to compete
effectively in the sale of modems, we will need to reduce our prices, and the
underlying costs, of our modems. As long as Sharp is the only manufacturing
source of our modems, our ability to reduce the manufacturing costs of our
modems may be limited.
We are dependent upon certain key suppliers for a number of the
components for our 64QAM products. For example, we have only one vendor,
BroadCom Corporation, for the 64QAM demodulator semiconductors that are used
in our client modem products, and in past periods these semiconductors have
been in short supply. In 1997, BroadCom announced a program whereby certain
of its technological and product enhancements may be made available to
certain of our competitors before making them available to us, thereby giving
us a competitive disadvantage. Hitachi is the sole supplier of the processors
used in certain of our modems. Stanford Telecom, which is a competitor for at
least one of our broadband wireless products, is currently the sole supplier
for certain components used in our products and has indicated that they might
stop supplying these components to us, although it has not yet done so. There
can be no assurance that these and other single-source components will
continue to be available to us, or that deliveries of them to us will not be
interrupted or delayed (due to shortages or other factors). Having
single-source components also makes it more difficult for us to reduce our
cost for these components and makes us vulnerable to price increases by the
component manufacturer. Any significant interruption or delay in the supply
of components for our products or any increase in our costs for components,
or our inability to reduce component costs, could hurt our business.
WE ARE IN AN INTENSELY COMPETITIVE MARKET, AND WE COMPETE WITH MUCH LARGER
COMPANIES.
Our market is intensely competitive, and we expect even more competition in
the future. The principal competitive factors in this market include:
- - product performance and features including both downstream and upstream
transmission capabilities,
- - reliability and stability of operation,
- - breadth of product line,
- - sales and distribution capability,
- - technical support and service,
- - relationships with cable and broadband wireless system operators and ISPs,
- - meeting standards compliance and
- - general industry and economic conditions.
While we believe our products and services are competitive with or superior
to those of our competitors, we have been hampered by a lack of resources, by
disruptions resulting from management and personnel changes, by uncertainties
caused by our financial reporting difficulties referred to at the beginning of
this report, and by our competitors having established relationships with
principal cable companies, wireless operators, and ISPs, including @Home.
Although our products have been particularly well received in the broadband
wireless market, financial difficulties among our wireless customers have
limited our sales to and collections from these customers until
18
<PAGE>
recently. In addition, conditions in our market could change rapidly and
significantly as a result of technological changes, and the development and
market acceptance of alternative technologies could decrease the demand for
our products or render them obsolete. Similarly, the continued emergence or
evolution of industry standards or specifications may put us at a
disadvantage in relation to its competitors. There can be no assurance that
we will be able to compete successfully in the future.
In general, our competitors are producers of asymmetric cable modems and
other types of cable modems and other broadband access products. Most of our
competitors are substantially larger and have greater financial, technical,
marketing, distribution, customer support and other resources, as well as
greater name recognition and access to customers, than we have. Many of our
competitors are in a better position to withstand any significant reduction in
capital spending by cable or broadband wireless system operators.
CABLE MODEM COMPETITORS. Our competitors in the cable modem market include
Cisco Systems, Com21, Terayon, Nortel Networks, Motorola, General Instrument and
3Com and its subsidiary U.S. Robotics. Other cable modem competitors include
Phasecom, Scientific-Atlanta, Toshiba and Zenith Electronics, as well as a
number of smaller, more specialized companies. Certain competitors have
established relationships in the cable industry and with @Home, which is the ISP
for a number of major cable operators, and have more experience than we have in
selling two-way cable transmission products. Some of these competitors have
entered into partnerships with computer networking companies and with @Home that
may give such competitors greater visibility in this market. A number of
competitors have already introduced or announced high speed connectivity
products that are priced lower than ours, and certain other competitors are more
focused on and experienced in selling and marketing two-way cable transmission
products.
Certain of our competitors have established relationships with cable system
operators and telephone companies ("telcos"), and ISPs, including @Home, and,
based on these relationships, may have more direct access to the decision-makers
of such cable system operators and telcos. In addition, we could face potential
competition from certain of our suppliers, such as Sharp, if it were to launch
or license competitive modems for sale to others.
The adoption of the DOCSIS cable standard by large cable operators has
adversely affected our ability to sell to cable customers, particularly new
customers. Further, our products are not compatible with headend equipment and
modems of other suppliers of broadband Internet access products, including
DOCSIS products, and, as a result, potential customers who wish to purchase
broadband Internet access products from multiple suppliers may be reluctant to
purchase our products.
WIRELESS CABLE COMPETITORS. Our principal competitors in the wireless
broadband wireless market include Nortel Networks (which is active in Canada),
Cisco Systems (which has proprietary products under development due to its
acquisition of Clarity Wireless, Inc.), COM21 (which is attempting to adapt its
proprietary cable systems for wireless), Phasecom and other vendors that may be
attracted by recent investments by MCI Worldcom and Sprint in wireless
operations. Stanford Telecommunications (which manufactures QPSK products) is
providing wireless Internet connectivity over LMDS frequencies and has added
telephone service, which is potentially attractive to new operators. Stanford
Telecom is the sole supplier for certain components used in our products and has
indicated that they might stop shipping these components to us. Our products
have been more widely accepted in the broadband wireless market than in the
cable market partly because the adoption of the DOCSIS standard has not had a
significant effect on wireless customers. We believe that products meeting the
present DOCSIS standard will not perform well over wireless. This belief is
based on the performance of the adaptive equalizer in the modem in the presence
of multiple signals, the power required from the transceiver in the return path
and the probable disruption of the TDMA return path in the presence of noise or
multi-path propagation. However, there can be no assurance that improvements in
integrated circuit technology, transceiver output power levels or changes in the
DOCSIS TDMA protocol will not allow systems developed for cable to perform
effectively over wireless. One of the DOCSIS compliant vendors might also modify
the DOCSIS equipment to a proprietary non-standard form to work over wireless.
19
<PAGE>
OTHER COMPETITION. Broadband wireless and cable system operators face
competition from providers of alternative high speed connectivity systems. In
the wireless high speed access market, broadband wireless system operators are
in competition with satellite TV providers. In telephony networks, xDSL
technology enables digitally compressed video signals to be transmitted through
existing telephone lines to the home. Market acceptance of xDSL, or other wired
technologies such as ISDN, or satellite technologies, such as DBS, could
decrease the demand for our products. Recently, several companies, including
Compaq, Intel, Microsoft, 3Com, Alcatel, Lucent, several RBOCs, MCI and others
announced the formation of a group focused on accelerating the pace of ADSL
service. Further, if any competing architecture or technology were to limit or
halt the deployment of coaxial or HFC systems, our business could be materially
adversely affected.
To be successful, we must respond promptly and effectively to the
challenges of new competitive products and tactics, alternate technologies,
technological changes and evolving industry standards. We must continue to
develop products with improved performance over two-way wireless transmission
facilities. There can be no assurance that we will meet these challenges.
EVOLVING INDUSTRY STANDARDS, COMPETING TECHNOLOGIES AND TECHNOLOGICAL
CHANGES MAY HURT OUR BUSINESS.
Our products are not in compliance with the DOCSIS standard that has been
adopted by a number of large cable operators, and this has adversely affected
our ability to sell to cable customers, particularly new customers. Further, our
products are not compatible with headend equipment and modems of other suppliers
of broadband Internet access products, including DOCSIS products, and, as a
result, potential customers who wish to purchase broadband Internet access
products from multiple suppliers may be reluctant to purchase our products. Our
products are not in compliance with the DAVIC specifications that are supported
in Europe. The emergence of these standards has hurt our business, and the
adoption of other industry standards in the future could have a further adverse
effect.
There are a number of competing technologies for providing high speed
internet access. Alternative high speed connectivity technologies include wired
technologies such as xDSL and ISDN. As indicated in "Competition" above, several
large companies have announced the formation of a group to accelerate the pace
of ADSL service. To the extent that customers view these or other alternative
technologies as providing faster access or greater reliability or
cost-effectiveness, sales of our products would be adversely affected.
The market for high speed Internet access products is characterized by
rapidly changing technologies and short product life cycles. The rapid
development of new competing technologies increases the risk that the
competitiveness of our products could be adversely affected. Future advances in
technology may not be beneficial to, or compatible with, our business and
products, and we might not be able to respond to the advances, or our response
might not be timely or cost-effective. Market acceptance of new technologies and
our failure to develop and introduce new products and enhancements to keep pace
with technological developments could hurt our business.
OUR MARKET IS NEW AND DEVELOPING, AND WE MUST DEPEND UPON CABLE AND
WIRELESS OPERATORS.
The market for broadband Internet access products has only recently begun
to develop and is characterized by an increasing number of market entrants and
competing technologies. Our success will depend primarily on our ability to sell
our cable and wireless modem systems to cable system operators and broadband
system operators and on their sales of our client modems to end-users.
In selling to cable system operators, we face a number of difficulties. Our
products are not in compliance with the DOCSIS standard that has been adopted by
a number of large cable operators and which is preferred by @Home, which has
adversely affected our sales. Also, our products are not compatible with the
headend equipment or modems of other suppliers. Many cable system operators and
their customers may be reluctant to adopt and commit to a technology such as
ours which has not gained wide acceptance among their industry peers. Certain of
our competitors have already
20
<PAGE>
established relationships in the cable market and with @Home, further
limiting our ability to sell products to penetrate the market. The cable
industry has undergone evolution and reorganization, which has adversely
affected certain of our customer relationships. Moreover, the extent to which
(and the manner in which) cable system operators will commit to providing
broadband Internet access remains uncertain. Cable system operators have a
limited number of programming channels over which they can offer services,
and there can be no assurance that they will choose to provide Internet
access. Cable service operators have little experience in providing Internet
networks or launching, marketing and supporting Internet services, and
providing such services will involve substantial capital expenditures. To the
extent that cable service operators elect to provide Internet access, there
is no assurance that they will choose to do so through our cable modem
systems.
We have become increasingly dependent on sales to broadband wireless system
operators and distributors. Our net sales to customers in the broadband wireless
industry increased from $2.4 million in 1997 to $4.7 million in 1998. The
adoption of the DOCSIS standard, which has adversely affected our sales to cable
system operators, has not had a significant effect on wireless customers. We
believe that products meeting the present DOCSIS standard will not perform well
over wireless, but this could change in the future as a result of modifications
in the DOCSIS TDMA protocol, improvements in technology or other developments.
Many broadband wireless system companies are in the early stage of development
or are in need of capital to upgrade and expand their services in order to
compete effectively with cable system operators, satellite TV and telcos. The
weak financial condition of many wireless customers has adversely affected our
sales to these customers and their ability to pay for the products we have
shipped to them. The principal disadvantage of wireless cable is that it
requires a direct line of sight between the wireless cable system operator's
antenna and the customer's location and the installation of an antenna at the
customer premises. Therefore, despite a typical range of up to 35 miles, a
number of factors, such as buildings, trees or uneven terrain, can interfere
with reception, thus limiting broadband wireless system operators' customer
bases. We estimate that there were only approximately 1.0 million wireless video
cable customers in the United States as of March 1998. In addition, current
technical and legislative restrictions have limited the number of analog
channels that wireless cable companies can offer in the most commonly used
frequency bands to 33. In order to better compete with cable system operators,
satellite TV and telcos, broadband wireless system operators have begun to
examine the implementation of digital TV and/or Internet access to create new
revenue streams. To the extent that such operators choose to invest in digital
TV, such decisions will limit the amount of capital available for investment in
deploying other services, such as Internet access. To the extent wireless
operators choose to provide Internet access, there is no assurance that they
will not select technologies other than our high speed modem system to do so
(such as Internet plus telephony, or new equipment standards such as DOCSIS with
which our products are not compatible). Moreover, broadband wireless system
operators will require substantial capital to introduce and market Internet
access products. There can be no assurance that broadband wireless system
operators will have the capital to supply Internet services in a competitive
environment. While many broadband wireless system operators are currently
utilizing telephone return for upstream data transmission, we believe that
wireless operators will demand two-way wireless transmission as more of these
entities obtain licenses for additional frequencies under the new FCC two-way
authorization for MMDS frequencies released in September 1998. Currently, we are
attempting to refine our products so as to satisfy the two-way transmission
needs of broadband wireless system operators, and our customers have six headend
installations in place to do this. But, there can be no assurance that we or our
customers will be successful in our efforts to make this a commercially viable
alternative to two-way cable. The failure of our products to gain market
acceptance would hurt our business.
WE DEPEND UPON A SMALL NUMBER OF CUSTOMERS.
A small number of customers has accounted for a large portion of our net
sales, and we expect this trend to continue. Our headend equipment and modems do
not operate with other companies' headend equipment or modems, and, as a result,
we are typically the sole source provider to our customers. The fact that our
customer base is highly concentrated increases our risk of loss as a result of
the loss of any of our principal customers. In 1998, Jones Intercable was sold
to Comcast and ceased purchasing our products, which adversely affected our
business. There is no assurance
21
<PAGE>
that our other principal customers will continue as our customers. The loss
of any of our principal customers would hurt our business.
THE SALES CYCLE FOR OUR PRODUCTS IS LENGTHY AND UNCERTAIN AND OUR OPERATING
RESULTS FLUCTUATE WIDELY.
The sale of our products typically involves a great deal of time and
expense. Customers usually want to engage in significant technical evaluation
before making a purchase commitment. There are often delays associated with
customers' internal procedures to complete the evaluation and to approve the
large capital expenditures that are typically involved in purchasing our
products. The sales cycle for our products has been lengthy, generally lasting
three to nine months, and is subject to a number of significant risks, including
customers' budgetary constraints and internal acceptance reviews. Because our
sales cycle may be long and uncertain, and because we depend on a relatively few
customers who place relatively large orders, any delay or loss of an order that
is expected to be received in a quarter can have a major effect on our sales and
operating results for that quarter. The same is true of any failure of a
customer to pay for products on a timely basis.
These factors, together with the other factors referred to in this "Risk
Factors" section, tend to cause our operating results to vary substantially from
quarter to quarter. These fluctuations have adversely affected the prices of our
Common Stock in the past and may adversely affect such prices in the future.
WE DEPEND ON KEY PERSONNEL.
Our success depends in significant part upon the continued services of our
key technical, sales and management personnel. Any officer or employee can
terminate his or her relationship with us at any time. Our future success will
also depend on our ability to attract, train, retain and motivate highly
qualified technical, marketing, sales and management personnel. Competition for
such personnel is intense, and there can be no assurance that we will be able to
attract and retain key personnel. The loss of the services of one or more of our
key personnel or our failure to attract additional qualified personnel could
have a material adverse effect on our business, operating results and financial
condition. We carry a $1.5 million key-person life insurance policy on Mr.
Ledbetter, our Chief Executive Officer.
WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY.
We rely on a combination of patent, trade secret, copyrights and trademark
laws and contractual restrictions to establish and protect our intellectual
property rights. We cannot assure you that our patents will cover all the
aspects of our technology that require patent protection or that our patents
will not be challenged or invalidated, or that the claims allowed in our patents
will be of sufficient scope or strength to provide meaningful protection or
commercial advantage to us. We have initiated one patent infringement lawsuit to
enforce our patent rights, and it resulted in a settlement in which we granted
licenses to the defendants containing certain terms that are in some respects
favorable for them, including a right of first refusal to purchase our patents
that we granted to one defendant (Com21, Inc.) in the event that in the future
we propose to sell our patents (separately or together with our other assets) to
any third party. (See Item 1 "Legal Proceedings.") We do not know
22
<PAGE>
whether we will bring litigation in the future in an effort to assert our
patent rights, or whether other companies will bring litigation challenging
our patents. Any such litigation could be time consuming and costly for us
and could result in our patents being held invalid or unenforceable.
Furthermore, even if the patents are upheld or are not challenged, third
parties might be able to develop other technologies or products without
infringing any such patents.
We have entered into confidentiality and invention assignment agreements
with our employees, and we enter into non-disclosure agreements with certain of
our suppliers, distributors and customers, in order to limit access to and
disclosure of our proprietary information. There can be no assurance that these
contractual arrangements or the other steps we take to protect our intellectual
property will prove sufficient to prevent misappropriation of our technology or
deter independent third-party development of similar technologies. The laws of
certain foreign countries may not protect our products or intellectual property
rights to the same extent as do the laws of the United States.
We have in the past, received, and may in the future receive, notices from
third parties claiming that our products, software or asserted proprietary
rights infringe the proprietary rights of third parties. We expect that
developers of wireless and cable modems will be increasingly subject to
infringement claims as the number of products and competitors in our market
grows. While we are not currently subject to any such claim, any future claim,
with or without merit, could be time consuming, result in costly litigation,
cause product shipment delays or require us to enter into royalty or licensing
agreements. Such royalty or licensing agreements might not be available on terms
acceptable to us or at all.
In the future, we may also file lawsuits to enforce our intellectual
property rights, to protect our trade secrets or to determine the validity and
scope of the proprietary rights of others. Such litigation, whether successful
or not, could result in substantial costs and diversion of resources. As
indicated above we were engaged during 1998 in an infringement lawsuit that we
brought against two third parties. In 1999, in order to stop the diversion of
resources caused by the litigation, we entered into a settlement pursuant to
which the defendants obtained licenses to our products on terms that in certain
respects were favorable to the defendants. (See "Patents" above and Item 1
"Legal Proceedings" below.) Nonetheless, we may find it necessary to institute
further infringement litigation in the future.
DEFECTS IN OUR PRODUCTS COULD CAUSE PRODUCT RETURNS AND PRODUCT LIABILITY.
Products as complex as those offered by us frequently contain undetected
errors, defects or failures, especially when first introduced or when new
versions are released. In the past, such errors have occurred in our products
and there can be no assurance that errors will not be found in our current and
future products. The occurrence of such errors, defects or failures could result
in product returns and other losses. They could also result in the loss of or
delay in market acceptance of our products.
GOVERNMENT REGULATION MAY ADVERSELY AFFECT OUR BUSINESS.
We are subject to varying degrees of governmental, federal, state and local
regulation. For instance, the jurisdiction of the FCC extends to high speed
Internet access products such as ours. The FCC has promulgated regulations that,
among other things, set installation and equipment standards for communications
systems. Further, regulation of our customers may adversely affect our business.
VOLATILITY OF OUR STOCK PRICE.
Our Common Stock has been delisted from the Nasdaq National Market and has
not traded on Nasdaq since mid-June 1998. Until the filing of this report, there
has not been current information regarding our business and financial condition
for over one year, and our previous financial statements have been restated. As
a result, it is difficult to estimate based on current information what the
price for our Common Stock will be if and when our stock is actively traded on a
public
23
<PAGE>
market. In addition, the market price of our Common Stock has fluctuated in
the past and is likely to fluctuate in the future.
INTERNATIONAL SALES COULD INVOLVE GREATER RISKS.
To date, sales of our products outside of the United States have
represented an insignificant portion of our net sales. To the extent that we
sell our products internationally, such sales will be subject to a number of
risks, including longer payment cycles, export and import restrictions, foreign
regulatory requirements, greater difficulty in accounts receivable collection,
potentially adverse tax consequences, currency fluctuations and political and
economic instability.
RISKS RELATED TO THE YEAR 2000 ISSUE.
BACKGROUND. The "Year 2000 Issue" refers generally to the problems that
some software, including firmware embedded in the Company's products, may have
in determining the correct century for the year. For example, software with
date-sensitive functions that is not Year 2000 compliant may not be able to
distinguish whether "00" means 1900 or 2000, which may result in failures or the
creation of erroneous results.
OUR READINESS PLAN. We have developed a Year 2000 readiness plan for the
current versions of our products. The plan includes development of corporate
awareness, assessment, implementation (including remediation, upgrading and
replacement of certain product versions), validation testing and contingency
planning. We continue to respond to customer concerns about prior versions of
our products on a case-by-case basis because we believe most products that could
be affected have been withdrawn from service.
We have largely completed our plan, except for contingency planning, with
respect to the current versions of all of our products in an effort to assure
that they are Year 2000 compliant. As a result of our readiness plan,
substantially all of the current versions of each of our products currently
offered for sale are Year 2000 compliant (with the exception of final quality
assurance and customer network testing), when configured and used in accordance
with the related documentation, and provided that the underlying operating
system of the host machine and any other software used with or in the host
machine or our products are also Year 2000 compliant. In some cases, our
products require an upgrade which is either sold as a complete substitute or as
a kit for in-service systems to be Year 2000 Compliant. We consider our products
to be Year 2000 compliant if they have the ability to: (i) correctly handle date
information needed for the December 31, 1999 to January 1, 2000 date change;
(ii) function according to the product documentation provided for this date
change without changes in operation resulting from the advent of a new century,
assuming correct configuration; (iii) where appropriate, respond to two-digit
date input in a way that resolves the ambiguity as to century in a disclosed,
defined, and predetermined manner; and (iv) recognize year 2000 as a leap year.
RISKS. Despite our testing and testing by our current customers, and any
assurances from developers of products incorporated into our products, our
products may contain undetected errors or defects associated with Year 2000 date
functions. Also, certain prior versions of our products are not fully Year 2000
compliant and may remain in service. Known or unknown errors or defects in our
products could result in delay or loss of revenue, diversion of development
resources, damage to our reputation, or increased service and warranty costs,
any of which could materially adversely affect our business.
We do not currently have any information concerning the Year 2000
compliance status of our customers. If our customers suspend or defer
investments in system enhancements or new products to address Year 2000
compliance problems, our business could be materially adversely affected.
Some commentators have predicted significant litigation regarding Year 2000
compliance issues. Because this type of litigation lacks precedent, it is
uncertain whether or to what extent we may be affected by it.
24
<PAGE>
We have an ongoing program in an effort to prevent any adverse effects
caused by the Year 2000 Issue with regard to our mission critical internal
information systems (including the third-party software for our management
information systems, networks and desktop applications, and our hardware
telecommunications technology). We expect to complete this program before the
end of 1999.
COSTS. We have funded our Year 2000 efforts from operating cash. While we
do not expect such costs to be material, additional costs will be incurred
related to Year 2000 programs for administrative personnel to manage our
readiness plans, technical support for our product engineering and customer
satisfaction. Although we are not currently aware of any material operational
issues or costs associated with preparing our internal information systems for
the Year 2000, we may experience material unanticipated problems and costs
caused by undetected errors or defects in the technology used in our information
systems. We can give no assurance that other material problems and costs will
not arise in connection with Year 2000 compliance or that these problems and
costs will not adversely affect our business.
CONTINGENCY PLANNING. We have not developed a comprehensive contingency
plan to address situations that may result if we are unable to achieve Year 2000
readiness of our critical operations. The cost of developing and implementing
such a plan may itself be material. We are also subject to external forces that
might generally affect industry and commerce, such as utility or transportation
company Year 2000 compliance failures and related service interruptions. Were we
to experience an unanticipated Year 2000 interruption, business operations could
be seriously impaired for an indefinite period of time until remedial efforts
could be achieved.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
25
<PAGE>
PART II. OTHER INFORMATION
II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
CLASS ACTION LITIGATION
In June 1998, five class action lawsuits were filed in San Mateo County
Superior Court, California against us, our five directors (one of whom is an
officer), two former officers and one former director. The lawsuits were brought
on behalf of purchasers of our Common Stock during the class period commencing
November 12, 1997 (the date of our initial public offering) and ending June 1,
1998. In July 1998, a sixth class action lawsuit was filed in the same court
against the same defendants, although the class period was extended to June 18,
1998. All six lawsuits also named as defendants the underwriters in our initial
public offering, but the underwriters have since been dismissed from the cases.
The complaints in these lawsuits claim that we and the other defendants
violated the anti-fraud provisions of the California securities laws, alleging
that the financial statements we used in connection with our initial public
offering and the financial statements we issued subsequently during the class
period, as well as related statements made on our behalf during the initial
public offering and subsequently regarding our past and prospective financial
condition and results of operations, were false and misleading. The complaints
also allege that we and the other defendants caused these misrepresentations to
be made in order to inflate the price of our stock for the initial public
offering and during the class period. We and the other defendants denied the
charges of wrongdoing.
In March 1999, the parties entered into an agreement in principle to settle
these lawsuits, as indicated below.
In July and August 1998, two class action lawsuits were filed in the
U.S. District Court for the Northern District of California. Both of these
federal class action lawsuits were brought against the same defendants as the
six state court class actions referred to above, except that the second
federal class action lawsuit also named as a defendant PwC, our former
independent auditors. (The underwriters in our initial public offering were
named as defendants in the first federal class action lawsuit but were
subsequently dismissed.) The class period for the first federal class action
lawsuit is from November 12, 1997 to June 1, 1998, and the class period in
the second class action lawsuit extends to June 17, 1998. The complaints in
both federal class action lawsuits claim that we and the other defendants
violated the anti-fraud provisions of the federal securities laws, on the
basis of allegations that are similar to those made by the plaintiffs in the
state class action lawsuits. We and the other defendants denied these charges
of wrongdoing.
We believe that the state and federal class action lawsuits hurt our
business during the latter part of 1998, made it more difficult for us to
attract and retain employees, disrupted our management, sales and marketing,
engineering and research and development staffs, contributed to our inability
during the year to complete the restatement of our financial statements and
adversely affected the sales of our products and services.
In March 1999, we and the other parties to the state class action lawsuits
and the federal class action lawsuits (other than PwC) reached an agreement in
principle to settle the lawsuits. The agreement is subject to the parties'
entering into a binding stipulation of settlement and approval by the U.S.
District Court for the Northern District of California. Under the agreement in
principle, (i) our insurers would pay $8.8 million on our behalf (and on behalf
of the other officer and director defendants), (ii) we would issue 3.0 million
shares of our Common Stock to the plaintiffs (the number of shares would be
increased proportionately to the extent that there are more than 10.5 million
shares of our Common Stock outstanding on the date of distribution so that, as
of such date, the plaintiffs would hold approximately 22.6% of all of the shares
of our Common Stock that are then outstanding), (iii) if we are acquired within
nine months after March 9, 1999, the date of the
26
<PAGE>
agreement in principle, then, in addition to the consideration referred to in
(i) and (ii), we would pay to the plaintiffs an amount equal to 10% of the
consideration received by our stockholders in the acquisition. As a result of
the agreement in principle and a related agreement between us and our
insurers, we have paid, and will not be reimbursed by our insurers for, $1.2
million in attorney's fees and other litigation expenses that would otherwise
be covered by our insurance, and we will not have insurance coverage for the
attorney's fees and expenses relating to the settlement that we incur in the
future.
SEC INVESTIGATION
In October 1998, the Securities and Exchange Commission began a formal
investigation of us and unidentified individuals with respect to our financial
statements and public disclosures. We have been producing documents in response
to the Securities and Exchange Commission's subpoena and are cooperating with
the investigation. A number of current and former officers and employees and
outside directors have testified or may testify before the Securities and
Exchange Commission's staff.
PATENT LITIGATION
In January 1998, we brought a lawsuit in the U.S. District Court for the
Eastern District of Virginia against Com21, Inc. and Celestica, Inc. in which we
alleged that the defendants infringed our patents. In response to our lawsuit,
Com21 initiated a declaratory judgment action six days later in the U.S.
District Court for the Northern District of California to obtain a declaration
that our patents are invalid and unenforceable and that in any event Com21 did
not infringe them. In February 1998, the action in the Eastern District of
Virginia was transferred to the Northern District of California, and the two
actions were consolidated. Pre-trial discovery continued in the consolidated
action until September 1998 when the parties agreed to stay the proceedings
while they attempted to reach a settlement. In January 1999, the parties entered
into a settlement agreement and the actions were dismissed. Pursuant to the
settlement, we granted Com21 and Celestica a nonexclusive license on our patents
under which they may be required to pay royalties in the event that they sell
certain products in the future, subject to certain contingencies, and we granted
Com21 a right of first refusal to purchase our patents in the event that we
propose in the future to sell our patents (whether separately or together with
our other assets) to any third party. We have agreed to pay our legal counsel in
this action, as a partial contingency fee (in return for such counsel's
acceptance of reduced current legal fees), an amount equal to 50% of any
royalties that we receive from our license with the defendants in the litigation
(but not in excess of $3,000,000). To date, we have received virtually no
royalties from the license.
LAWSUIT FILED BY PACIFIC MONOLITHICS
In March 1999, Pacific Monolithics, Inc. (which had filed a voluntary
petition under Chapter 11 of the U.S. Bankruptcy Code and is suing as
debtor-in-possession) filed a lawsuit in Santa Clara County Superior Court,
California against us, our five directors (one of whom is an officer), a former
director (who was subsequently dismissed), a former officer and PwC. The lawsuit
concerns an agreement which we entered into in March 1998 to acquire Pacific
Monolithics through a merger, which acquisition was never consummated. The
complaint alleges that we induced Pacific Monolithics to enter into the
agreement by providing it with our financial statements, and by making other
representations concerning our financial condition and results of operations,
which were false and misleading, and further alleges that we wrongfully failed
to consummate the acquisition. The complaint claims the defendants committed
breach of contract and breach of the implied covenant of good faith and fair
dealing, as well as fraud and negligent misrepresentation. The complaint seeks
compensatory and punitive damages according to proof, plus attorneys' fees and
costs. The plaintiff has attempted to initiate discovery, which defendants have
opposed on the basis that the plaintiff and the Company had agreed that any
disputes would be submitted to arbitration. The defendants have filed a motion
to compel arbitration and to stay the court action. The Company does not
believe, based on current information (which is only preliminary, since
discovery has not commenced in the litigation), that the outcome of this
litigation will have a material adverse impact on the Company's financial
statements.
27
<PAGE>
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Form S-1 Registration Statement (SEC File No. 33-36001) related to the
Company's initial public offering of Common Stock, $0.001 par value per share,
was declared effective by the SEC on November 11, 1997. A total of 3,105,000
shares of the Company's Common Stock was registered with the SEC with an
aggregate registered offering price of $43,470,000, which consisted of 2,836,053
shaes registered on behalf of the Company (with an aggregate registered offering
price of $39,705,000) and 268,947 shares registered on behalf of certain
stockholders of the Company (with an aggregate registered offering price of
$3,765,000). The offering commenced on November 12, 1997 and all 2,836,053 and
268,947 shares of Common Stock being offered by the Company and certain
stockholders of the Company, respectively, were sold for the aggregate
registered offering price through a syndicate of underwriters managed by
NationsBanc Montgomery Securities and UBS Securities. The offering terminated on
November 12, 1997, immediately after all of the Common Stock was sold.
The Company and the selling stockholders paid to the underwriters an
underwriting discount totaling $2,779,000 and $264,000, respectively, in
connection with the offering. In addition the Company reasonably estimates that
it incurred additional expenses of approximately $1,184,000 in connection with
the offering. Thus the net offering proceeds to the Company and the selling
stockholders were approximately $35,737,000 and $3,502,000, respectively. The
underwriting discount and the other offering expenses were not made directly or
indirectly to any directors, officers of the Company (or their associates), or
persons owning 10% or more of any class of equity Securities of the Company or
to any other affiliates of the Company.
Through June 30, 1998 the net offering proceeds to the Company have been
utilized as follows:
<TABLE>
<CAPTION>
Direct or indirect payments to
directors, officers, general partners
of the Company or their associates;
to persons owning ten percent or
more of any class of equity
securities of the Company; and Direct or indirect
Use to affiliates of the Company payments to others
- ---------------------------------- --------------------------------------- -------------------
<S> <C> <C>
Construction of plant,
building and facilities -- --
Machinery and equipment -- $ 2,853,000
Purchase of real estate -- --
Acquisition of other business(es) -- --
Repayment of indebtedness $ 1,371,000 5,627,000
Working Capital -- 13,931,000
Temporary investment in
Alex Brown Investment Account
and General Bank Account -- 11,955,000
Other purposes -- --
</TABLE>
28
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed as part of this report:
<TABLE>
<CAPTION>
Exhibit No. Description of Exhibit
----------- ----------------------
<S> <C>
27.01 Financial Data Schedule.
</TABLE>
(b) Reports on Form 8-K
On June 19, 1998, the Company reported under Item 5. "Other Events" that
Coopers & Lybrand, the Company's independent accountants at that time,
had notified the Company that its reports with respect to the financial
statements of the Company as of December 31, 1997, and for the year then
ended, and as of September 30, 1997, and for the nine months then ended,
should no longer be relied upon.
29
<PAGE>
HYBRID NETWORKS, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: June 9, 1999 HYBRID NETWORKS, INC.
/s/ Carl S. Ledbetter
----------------------------------
Carl S. Ledbetter
Chief Executive Officer
/s/ Judson W. Goldsmith
----------------------------------
Judson W. Goldsmith
President and
Chief Financial Officer
(Principal Financial Officer)
30
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE 6/30/98
BALANCE SHEET AND THE STATEMENT OF OPERATIONS FOR THE SIX MONTHS THEN ENDED AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 10048
<SECURITIES> 1499
<RECEIVABLES> 1625
<ALLOWANCES> 100
<INVENTORY> 8803
<CURRENT-ASSETS> 22846
<PP&E> 5970
<DEPRECIATION> 1514
<TOTAL-ASSETS> 27860
<CURRENT-LIABILITIES> 11464
<BONDS> 0
0
0
<COMMON> 10
<OTHER-SE> 15787
<TOTAL-LIABILITY-AND-EQUITY> 27860
<SALES> 4949
<TOTAL-REVENUES> 4949
<CGS> 6068
<TOTAL-COSTS> 6068
<OTHER-EXPENSES> 10547
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 459
<INCOME-PRETAX> (11467)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11467)
<EPS-BASIC> (1.10)
<EPS-DILUTED> (1.10)
</TABLE>
